How “Books and Records” Rewrote the Rulebook

One of the most important developments in Delaware corporate law recently has been the expansion of shareholder rights to company information. Shareholders can now use their general right to inspect a company’s “books and records” (Section 220 of the Delaware General Corporation Law) to obtain internal communications among directors and between them and their third-party advisers, including occasionally private emails or LinkedIn messages. Shareholders can then use the internal documents to show disclosure deficiencies and conflicts of interests, thereby overcoming what once seemed insuperable hurdles to pleading in litigation. Section 220 has thus turned into a powerful shareholder protection tool, with important implications for deal negotiations and oversight duties.

My new article, “Corporate Law, Retooled: How Books and Records Revamped Judicial Oversight,” explains how Section 220 rose to prominence and assesses the desirability of a new version of corporate litigation where much of the action occurs pre-filing.

In the 2000s, corporate litigation came to be dominated by strike suits.[1] Litigation did little good in terms of compensation and deterrence, and so it made sense to recalibrate it.[2] Delaware courts responded by relaxing the standards of judicial review and granting more deference to market mechanisms. A string of dramatic decisions in the mid-2010s, spearheaded by Corwin,[3] raised the pleading bar: By allowing decision-makers to take advantage of the deferential business judgment review if their actions received shareholder approval, the courts made it harder for lawsuits to survive a motion to dismiss and reach discovery.

Commentators held widely opposing views on the desirability of Corwin. Some predicted that it would insulate managers from accountability and lead to a deterioration in corporate governance.[4] Others lauded the shift from judicial involvement to a market mechanism (the shareholder vote), noting that today’s sophisticated institutional investors can fend for themselves.[5] Yet in retrospect, both camps failed to account for a crucial point: Corwin and its progeny were just the first step in the recalibration of corporate litigation and cannot be analyzed in isolation.

The second step was the expansion of shareholders’ inspection rights. In a series of recent decisions, Delaware courts liberalized inspection rights laws, making it easier for shareholders and their attorneys to plead around a Corwin defense. For example, when courts allow shareholders to access even informal electronic communications, they significantly enhance shareholders’ chances of showing contradictions between insiders’ public and private statements, creating possible grounds for a claim that the shareholder vote was uninformed and so the Corwin defense is inapplicable.

In other words, Corwin increased the demand for pre-filing investigatory tools (in order to survive the motion to dismiss), and then Delaware courts made sure that supply met demand (by liberalizing inspection rights). Section 220 requests thus quickly became a necessity in deal litigation, just as they were in oversight duties (Caremark) litigation. Understanding Section 220’s impact therefore becomes important to understanding how corporate law operates, and why Corwin and MFW did not have the predicted effect of limiting corporate law’s role in regulating business behavior.

My article’s second contribution is in assessing the costs and benefits of this shift to a front-loaded mode of corporate litigation. Section 220 actions now consume sizeable resources of the demanding shareholder, the company, and the courts. Beyond the direct costs, expanded Section 220 actions also carry the risk of subjecting companies to excessive and disruptive inquiries, which may lead to creating unnecessary paper trails and discourage risky but worthwhile business decisions.

Still, the expansion of shareholders’ right to information mitigates the fear that Corwin would lead to early dismissals of meritorious claims. It facilitates managerial accountability across a wide range of situations – from negotiating transformational transactions to overseeing legal risks. It helps plaintiffs rebut the presumptive deference to a shareholder vote (overcoming the Corwin and MFW defenses[6]), rebut the presumptive validity of a single-bidder process (overcoming C&J Energy[7]), and expose weaknesses in a company’s oversight (reinvigorating Caremark[8]). Further, the expansion of Section 220 contributes not just to legal deterrence, but also to market (reputational) deterrence. Pre-filing investigations produce a positive externality of quality information on how companies behave. To the extent that such information becomes public, third parties can use it to decide with whom to do business.

Expanding Section 220 also avoids overreliance on a shareholder vote as a governance mechanism. There is much evidence that shareholders almost automatically approve even complex or conflicted transactions because of information asymmetries, coordination problems, and conflicted interests. They often know only what insiders choose to reveal in public filings and are, in effect, stuck with the transaction as presented. The “books and records” expansion mitigates some of these flaws by improving the quality of available information and facilitating effective monitoring through active shareholders and plaintiffs’ attorneys.

Overall, the expansion of Section 220 is socially desirable. Delaware courts have been effectively micro-managing the volume and scope of discovery, keeping costs in check while allowing plaintiffs’ attorneys to vigorously monitor potential corporate wrongdoing. Still, the new emphasis on pre-filing investigations may not be sustainable. Precisely because pre-filing investigations have become so effective in deterring misbehavior, companies are now searching for ways to dilute their effects, such as  by requiring employees to sign inspection rights waivers before receiving stock options. And some plaintiffs prefer to file suits outside Delaware, in states that do not require costly pre-filing investigations. My article offers ways to mitigate this troubling trend, such as by using the “lead plaintiff” or “adequate representation” designations as carrots or sticks.

ENDNOTES

[1] Jill E. Fisch, Sean Griffith & Steven Davidoff Solomon, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93 Tex. L. Rev. 557 (2015).

[2] J. Travis Laster, Changing Attitudes: The Stark Results of Thirty Years of Evolution in Delaware M&A Litigation, in Research Handbook on Representative Shareholder Litigation 202 (Griffith et al., eds., 2018).

[3] Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015).

[4] E.g., Iman Anabtawi, The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence, 43 Del. J. Corp. L. 161 (2019).

[5] E.g., Zohar Goshen & Sharon Hannes, The Death of Corporate Law, 94 N.Y.U. L. Rev. 263 (2019).

[6] Kahn v. M&F Worldwide Corp., 88 A3d 635 (Del. 2014).

[7] C&J Energy Services, Inc. v. Miami General Employees, 107 A.3d 1049 (Del. 2014).

[8] In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1999).

This post comes to us from Roy Shapira, professor of law at the Interdisciplinary Center (IDC). It is based on his forthcoming article, “Corporate Law, Retooled: How Books and Records Revamped Judicial Oversight,” forthcoming in the Cardozo Law Review and available here.

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